Home Equity Loan or Home Equity Line of Credit - Which is
Right for You?
When a homeowner decides to take a
second mortgage or home equity loan out on
her home she has a few decisions to make. First, she'll need to decide on the
amount she'd like to borrow based on the amount of equity she has in her home.
She'll need to decide on a lender, although people will commonly try to use the
same lender they obtained their primary mortgage from, and she'll need to decide
whether a traditional home equity loan or a home equity line of credit is the
best choice for her.
Home equity loan vs. Home equity line of credit – What's the
difference?
There are a number of differences between a traditional
home equity loan and a
home equity line of credit. There are a number of similarities as well. Both
types of accounts result in a lien being placed in the second position against
your home. Both have a maturity date by which the loan must be repaid in full.
Both charge an interest rate, although the rates between the two may differ.
The majority of the differences between the two types involve the method of
delivery and repayment of the loan amount.
Home equity loan
A traditional home equity loan is a straightforward installment loan. The amount
borrowed against the equity in the home is delivered to the borrower in one lump
sum payment. The borrower must them make (usually monthly) installment payments
to repay the loan. This continues until the loan's maturity date, at which time
the entire loan must be paid in full (typically the last installment payment will
fall on or before the maturity date although some loans may require a double
payment be made as the final installment).
The advantages of this straightforward type of loan over the home equity line of
credit are few. The chief advantage is that the interest rate is usually set as
a fixed rate. Getting the money entirely up front can sometimes be a disadvantage
because once it's gone, it's gone. A home equity line of credit differs.
Home equity line of credit (HELOC)
A home equity line of credit (typically referred to as a HELOC in the banking
world) works more like a revolving charge account such as a credit card. The
amount borrowed against the equity in the home is set up as a credit line that
the borrower can use and repay as she sees fit. Just like a credit card, when
a withdrawal is made from the line the available credit decreases by that amount.
As payments are made the available credit increases. Interest is charged on
these accounts as well and they also have a maturity date by which all outstanding
amounts must be paid and the line is no longer accessible.
There are several advantages to the home equity line of credit over the regular
equity loan. Because the account is revolving, the funds can be used and repaid
several times over the life of the account. Interest is typically a lower rate
on home equity line of credit accounts and is only charged on the outstanding
balance, rather than the full amount (unless the full amount is withdrawn). The
only real disadvantage is that the interest rate is usually variable and could
be raised several times over the life of the account.
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